An article your future self will thank you for reading: superannuation, explained

An article your future self will thank you for reading: superannuation, explained

Young Australians aren’t thinking about super—perhaps the most money you will have in your lifetime—enough. Here’s how it works and why you should care about it. Image source: Konstantin Evdokimov via Unsplash.

By Jordan White | @JordanBWhite1

The last thing young Australians want to think about is retirement. But unlike uni assignments, superannuation—potentially the most money you will have in your life—isn’t something you can leave for your future self to worry about.

Young people don’t really think about superannuation or “super”, the main source of funding retirement in Australia.  18 to 34-year-olds are three times less interested in superannuation compared to older generations, according to a 2017 Financial Services Council report.

But Adelaide University chair of finance, Professor Ralf Zurbrugg, said young people should care about super because it relies on time and is the largest contribution to retirement living standards.

“It is a well-known psychological trait that we humans will discount the future, particularly if it is in the distant horizon.”

“If you need to take an examination in two months’ time but because it seems quite far away you think to yourself, ‘I’ll leave it for a few more days before I’ll start studying’.”

“Of course, if you say this too often to yourself you might find the exam is only a couple of days away and you haven’t prepared yourself enough for it! This also applies to your retirement,” Professor Zurbrugg said. 

How does superannuation work?

Superannuation is money put aside by your employer during your working life used to help fund your retirement. This money is invested on your behalf and can be accessed once you reach preservation age.

As of July 1 2021, employers need to put at least 10 per cent of an employee’s earnings into their super fund. This rate, the superannuation guarantee, is legislated by the government and is set to increase over time.  

This money is managed on your behalf by a super fund. Super funds employ experts to decide where to invest your money and charge a fee in return.

There are two types of funds retail funds, which have shareholders, and industry funds, who seek to benefit its members. Industry funds generally have lower fees and perform better (though past performance does not indicate future performance).

Fees are either a dollar amount of percentage of your super (or both). Super funds charge different fees so it is important to “shop around” when selecting a fund.

The ATO’s YourSuper tool compares the fees and performance of over eighty super funds. Whether you can choose your own fund depends on your employer.

Though super is compulsory for all Australians earning above $450 a month, you can also make personal (voluntary) contributions to help grow your super.

Investment options

Funds invest your money in a wide range of investment options, often with growth targets in mind.

These options can include Australian and/or international shares, property, fixed interest, or cash.

Naturally, some assets are riskier than others and so your fund produces pre-mixed growth, balanced, or conservative investment pools for you to choose from. 

A ‘growth’ fund might rely more on a mixture of shares or property instead of cash. These former assets are riskier in nature but could yield higher returns.

Younger people generally have more time to tolerate risk and could benefit from a growth option. However, you need to consider the level of risk you’re comfortable with.  

The power of time

Albert Einstein apparently said compound interest was the eighth wonder of the world. Whether or not he did, compound interest is magical and could help grow your super into a hefty sum.

Professor Zurbrugg said time is the most important thing when it comes to super and people should strongly consider making extra contributions early if they can.

“The way in which superannuation works is that you only have to put away a little bit of your money now to generate a tidy lump sum when you retire because there is a lot of time left before retirement.

“The longer the time before retirement, the greater the returns you can earn on the contributions that you make. In other words, what counts a lot is when you start contributing to your superannuation rather than how much you contribute,” he said.

Let’s look at an example.

A 22-year-old earning $60,000 a year (with $8000 in super) will have an estimated balance of $435,565 at age 65, according to MoneySmart’s superannuation calculator.

Approximately $250,000 of this end figure consists of employer contributions. The rest is some $185,000 in compound interest.

Contributing an extra five per cent of pay pre-tax (approximately $126,000) yields an estimated balance of $615,612  – about $231,000.

Voluntary contributions

You can boost your super by making voluntary (personal) contributions. These can be made before tax (a concessional contribution) or after tax.

Taxed at 15 per cent, pre-tax contributions could be tax effective depending on your income. The government also makes a co-contribution for post-tax contributions of up to $500 a year for low and middle income earners.

Up to $30,000 of voluntary contributions can be pulled from your super for a house deposit under the first home super saver scheme

“Even if you can only spare a few hundred bucks here and there, it will all add up because that money will earn a return as it is invested for you by the superannuation fund,” Professor Zurbrugg said.

How much super do I need?

According to AMP, the average super balance for 20-24 year-olds is $9481 for men and $8051 for women. This amount will only grow with time but what about when you retire?

Hang on, let me shake my magic eight ball…

Of course, this depends on many factors like your boujee lifestyle or lack thereof and how long you’ll live.

The Association of Superannuation Funds of Australia (ASFA) estimates that a super fund of $545,000 or $640,000 for singles and couples respectively is needed to fund a ‘comfortable’ retirement.

A “comfortable” lifestyle includes regular leisure activities, private health insurance, a reasonable car, good clothes, and domestic and occasional international holidays. These metrics are subjective and the best route is to have as much super as possible.     

A word on ethical funds

An ethical super fund invests in socially and environmentally ‘ethically responsible’ industries. Examples include Australian Ethical, UniSuper, and Future Super.

They are increasingly popular among young people. Australian Ethical, for instance, quadrupled the amount of super it manages from $639 million to $2.4 billion between 2014 and 2019.  

However, Professor Zurbrugg warns just because a fund labels themselves as “green” or “ethical”, this may not always be the case.

“Ethical and green funds have become very popular. This has spurned a large number of funds to advertise themselves as ethical/green.”

“A closer look at where they are investing your money can sometimes reveal they are not as green as you would expect. If this is something that interests you it is worth spending some time investigating the ‘greenness’ of the fund,” Professor Zurbrugg said.

Any advice in this article is general in nature and does not constitute personal financial advice. Please seek professional advice tailored to your individual circumstances before acting on any information in this article.

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